Goldman's Latest Worry: The Martin Act

No, not as the infamous client No. 9 who was said to have worn his black socks while he had sex with prostitutes, but as a prosecutor willing to use a New York State law known as the Martin Act to squeeze into submission one of Wall Streets biggest and most powerful players.

People inside Goldman Sachs (GS) concede that the latest probe of the firms activities during the 2007-2008 financial meltdown--launched by Manhattan District Attorney Cy Vance--could pose even bigger problems for the firm than anything stemming from the Securities and Exchange Commission or the U.S. Justice Department thanks to broad powers the Martin Act gives to prosecutors to file criminal charges against individuals and companies.

Under the Martin Act, its easier for prosecutors in New York state to bring criminal charges because they dont have to show the same high level of intent to commit crimes that prosecutors do under federal securities laws.

The Martin Act is a very broad statute, therefore it doesnt require the same showings of intent than you do on the federal level, says Harvey Pitt, former chairman of the Securities and Exchange Commission, and a prominent white-collar attorney who represented jailed financier Ivan Boesky. New York prosecutors have picked up on this and feel its a much more useful tool than the federal securities laws in cracking down on white collar crimes.

The Martin Act has been around since 1921, but it wasnt until 2002 that it became a major weapon to crack down on white-collar crime. Thats when former New York Attorney General Spitzer launched Martin Act investigations against major Wall Street firms and executives over allegations that they misled investors into buying worthless technology and telecom stocks with fraudulent stock research.

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Spitzer, who went on to become governor and then resigned over the prostitution scandal, never filed criminal charges against the firms during this time, but the threat of using the Martin Act to file criminal charges forced the major Wall Street firms to cough up more than $1 billion in fines and penalties. Several major analysts, such as Henry Blodget, formerly of Merrill Lynch, and Jack Grubman of Citigroup, were barred from the securities business because of their research. Citigroup (C) CEO Sandy Weill announced that he was stepping down from the job after Spitzer investigated how he prodded Grubman to upgrade a stock and then helped Grubman get his children into an exclusive New York preschool.

While many attorneys and securities analysts say they doubt Goldman will get indicted, they can see a similar situation in which Vance prods the firm to make management changes, such as ousting its CEO, Lloyd Blankfein, rather than face Martin Act charges. On Thursday, shares of Goldman plummeted after reports that Vances office had subpoenaed Goldman, and analysts tell FOX Business the decline was at least partially related to heightened investor concern over a Martin Act prosecution and the possibility it could focus on Blankfein.

Blankfein is in the hot seat because the New York DAs probe stems from a report by Senator Carl Levin, who investigated Goldmans activities during the financial crisis; Levin says Blankfein may have committed perjury when he gave testimony to his committee that downplayed Goldmans strategy during the crisis of betting against bonds tied to the housing market, while selling those same securities to its clients.

A Goldman spokesman had no comment on Vance's motivations as part of a possible Martin Act prosecution other than to say that "the testimony we gave was truthful and accurate and this is confirmed by (the Levin committee's) own report." Meanwhile, a spokesman for the New York District Attorneys office had no comment, though Vance appears to know full well the power of the Martin Act in bringing cases against big Wall Street firms. Since taking office last year, he has created a unit dedicated to cracking down on white-collar crime, and in speech earlier this year, he called the Martin Act too lenient, adding that my focus is on (the Martin Acts) future and broader application. In the coming year, in part because of new relationships with enforcement partners and a proactive approach, I expect you will see the Martin Act as a criminal enforcement tool.